Where Should the Enterprising Investor Focus These Days?

In my book "Ben Graham Was a Quant; Raising the IQ of the Intelligent Investor" in Chapter 8, I state that if Ben Graham was an active investor today, his recipe for success would probably include some other pertinent factors we should include or consider in the wake of our current economy being dominated by financial companies and the service-based sector.  Similarly, in Chapter 6, I state that “empiricism suggests the main drivers of stock returns are often market trading forces more than underlying business financials, especially in down markets when fear is leading the investment decisions rather than fundamentals.” 

Well, what I believe is probably most important to add at this time is leverage or quality ratios.  The flight from leverage in 2008 was really extreme and you saw the bounce back in 09.  Most quant models in practice, especially when predicated on regression back-tests favor value and quality (not value or quality).  Hence most traditional value investor’s holdings typically are also of higher quality and they didn’t participate in the 09 performance rebound (as much) unless they were “value only” investors of which few are.  The “value and quality” paradigm exists because value factors are so intrinsically implemented in the most quant models directly but quality simply because of its correlation with out-performance.  That is, in the cross-section of returns, those that out-perform most through time are those that tend to get the capital structure most right and those not highly leveraged are found in the top fractiles.

Secondly, Credit Default Swaps came out in 1998 I believe, and capital structure arb player Hedge Funds’s started shortly thereafter.  That has meant a slow but steady increase in correlation between the corporate bond market and equities.  Thus, it seems to me that a prescient activity for fundamental equity investors should involve getting a better understanding of the underlying debt/asset ratios and look for value predicated on the intrinsic value of the equity.  Cutting on these factors may not identify buy candidates but they will identify candidate stocks to avoid.

Now in down markets when fear is leading the charge of influence of stock return, stocks disconnect from fundamentals.  Thus, buying low volatility (low g-Factor, low Beta) stocks when the VIX is increasing is a good strategy, as long as you sell them and buy high vol (high g-Factor, high Beta) stocks when the VIX is decreasing.  Thus, working with incorporating volatility into your strategy can pay dividends when minor ELE events are happening.  I believe in addition to paying attention to the corporate debt side of the equation, a lot can be garnered by studying the implied vol of a company’s option chain.  That gives the trader’s view of where the stock is going.

In terms of their weighting?   That’s difficult to say a bit unless one spends some time modeling the factors you uncover along these lines relevant to return.  Each investor must determine that for themselves.

How Much Corporate Tax is Enough? NYTimes says GE pays too Little!

The New York Times recently ran an article (http://finance.yahoo.com/news/Here-How-General-Electric-GE-wscheats-2926862183.html?x=0), recently referred to on Yahoo Finance.  Some call it an expose on the lack of taxes General Electric (GE) paid.  In this article they claim GE is a “welfare recipient”.  However, what is lacking in these details is a fair and honest interpretation of the facts.  When you approach the business of corporate taxation from the prospective that corporations exist for the welfare of the state, and that any profits they make should somehow be available to the societies they live in, well then you may as well have the government take ownership and nationalize all public corporations.  This experiment has been done already and we called it communism.  When the New York Times comes down hard on the percentages of tax our S&P 500 companies should be paying, it’s almost communism they are espousing.  They conclude that somehow, whatever the tax, it’s just too low when these corporations are making billions and that the U.S. government has a right by fiat to confiscate a higher percentage of corporate profit.  As if they “owe” the government something, or like you and I owe the government something.  We don’t owe them anything, taxation isn’t covered in the constitution.  

Well, forgetting about the obvious “Chavez-Castro” behaviors these ideologies foster, it’s important to realize a couple of specifics.  First, major U.S. corporations employee hundreds and thousands of Americans.  What is the amount of taxes these employees pay on their hard earned income, before they leave earnings and profits to the company?  What if you add these amounts to the corporate contribution to our tax-roll, then how much are these companies paying to society as a whole?

Secondly, much of the complaint in the article from the NYTimes about GE, has much to do with re-patriating foreign earned income.  When GE or Exxon or Walmart or Google earns money overseas, do you think those governments do not tax these monies?  So, then the New York Times and its ilk, would bring those dollars back to the U.S. and re-tax them on the full amount of earnings, not on the amount leftover after foreign tax.  I for one, believe double taxation is evil and morally wrong.  It’s confiscation, not taxation. 

Let’s put this concept into perspective.  If you have a good business idea and form your own corporation exporting Arizona wines (a recent terroir found well for grape growing) to China, you might elect to have Chinese consumers pay you in dollars or perhaps maybe if it’s a small amount they’d pay you in Chinese Yuan.  Then, maybe you’d open a bank account in Hong Kong and keep a percentage of profits there, to cover some costs your business might incur in Yuan denominations, costs to distributors for instance.  You are thinking about expanding your business to Vietnam and maybe Singapore and are working on some deals with other distributors who you’re planning on paying in Yuan.  So, you leave that money there and each and every month add to it a bit with overseas profits while you’re making deals, and take some profits home to the U.S. also.  Eventually after some time, that small amount in the HK bank becomes equal to your year’s income back in the U.S. from the profits you did re-patriat.  Now, a NY liberal sees this money in your account, or hears about it from a cocktail party and reports you to the IRS and says, “ that’s unfair, they need to bring that money back to the U.S. and pay taxes on it”.  Meanwhile, you’ve had to file a Hong Kong tax report and pay taxes on those earnings as you’ve earned them all along.

This in simplicity is what we’re talking about in regard to foreign earned income.  Besides the fact, that corporate profits are not the U.S. government’s money, nor U.S. citizens money not counting the fact that major corporations are “citizens” of the world anyway, that money is destined for investment, somewhere, eventually and of course is taxed by those authorities in each country wherever it’s used.  To my knowledge, any person nor a corporation can escape taxation entirely, eventually it catch up with you, somewhere and for the S&P 500, they can’t hide, they’re just too big. 

So, using FactSet software and Standard & Poors data, I downloaded the S&P 500 taxes, income, pre-tax and EBIT numbers and formed the ratio of taxes paid to these other parameters.  Here’s how the top 25 largest corporations in the U.S. fair.

As you can see from this data, GE is number 6 on the list, it paid 7.4% of pre-tax income in taxes.  But look at the other companies.  Are their taxes to low?  Would you like to see all these numbers closer to 60% or higher?  If so, then you can expect the U.S. economy to run much slower than it is now and unemployment to run much higher.   You cannot expect to have growth, to have corporations create jobs when a significant percentage of profits go to tax.  These numbers are pretty disparate, but indeed some are fairly large.  Are Exxon and Chevron’s contributions of over 40% of pre-tax income high enough?  The numbers below are the averages across the S&P 500 over 2010.

This tells me that 24.3% of pre-tax income is paid by the S&P500 on average per corporation.  That’s a good number.   Yes GE is low on the list, but this has much to do with claiming tax credits due to many technologies that the government is incenting due to their “green” nature along with the foreign profit impact.  Now, if you’re “green” and have been crying for corporations to “go green”, since green is generally more costly than not, you need to provide incentives for them to do so.  For instance, years ago I owned a small “farmette” that included 13.6 acres.  Given this room, I looked into building a windmill and battery bank to provide my own electricity.  The out-of-pocket costs were $20,000, while my monthly electric bill at the time was $54.  Do the math.  My return on investment would have been taken 20 years.  Why would I do this?  This was in “cloudy” upstate New York and though on my mountain top there was plenty of wind, there were no tax credits for windmills, only solar so again, why would I or anyone make this investment?  Now you’d ask then, why is it different for a major corporation?  Why should they switch to green technologies that are more costly without incentives (i.e. tax credits)?  So goes it with GE.  Whirlpool for instance also hasn’t’ paid much tax (its number 395 on the list, not shown) and has paid -10% as ratio of tax to pre-tax income.  Why?  Because of the tax credits they get for making “Energy Star” appliances.  So when environmentalists all go out and buy “low wattage, energy efficient” refrigerators, furnaces and dishwashers, they can thank their U.S. government for subsidizing their manufacture and of course, these incentives for corporations to go “green” both in terms of what they manufacture and use. 

In general, there are many people in this country who generally, are more socialist in their thinking, and more “European” like in their policies, and would have the U.S. move toward the European model in the relationship between the corporations and government.  If you are one of those people, understand there is no “free tax”.  The more you take from corporations (and individuals) the stronger the ramifications to growth in the economy will be.  There is no way around this.  Company’s need money to invest and when the government confiscates it in higher taxes, there will be net less investment, less job growth and it will create an incentive for these very large companies to do business elsewhere.  The result will just be to allow the emerged market countries to close ranks with us sooner and we’ll lose business and wealth to them just faster.

Inflation? Ben says no, General Mills and Warren Buffett say Yes!

Recently, I had the opportunity to hear economist Ken Rogoff, author of “This Time is Different” along with Ian Bremmer of Eurasia group and author of “The J Curve” speak.  I even exchanged books with Ken and gave Ian one of my own.  Though these guys have very different styles, what was important to realize is that both men are NOT optimistic about the future of the developed world’s economies.  For instance, recently we read in the WSJ that Portugal estimates they need $99 billion (U.S. equivalent) to keep from defaulting, while simultaneously their prime minister failed to get a key austerity budget passed.  It appears the Portuguese politicians really are ignorant of their situation.  The continued cries from Greece public employee unions to avoid budget cuts at all costs also shows the severity of the misunderstanding the populace about the situation in Greece and Portugal, two of the PIIGS states.   You have to be mindful that “bailing” out the Eurozone can only be a drag on the world’s largest market (yes the Eurozone is larger than the U.S.) and France is willing to spend as much of the German GDP as possible to quiet the countries of the PIIGS fall. 

Meanwhile, at home the U.S. Treasury led by “banana Ben” refuses to acknowledge the cost increases of most commodities, major goods, oil and that inflation is not a threat, but is already here.   A nail in this coffin is a quote from Ken Powell CEO of General Mills, makers of my favorite cereal Cheerios, where he says, “we don’t pass on pricing anywhere near the full level of inflation” but General Mills are raising prices and state expectations of rising costs of grains to be between 4% to 5% by 2012.  How long can we put off the costs of foodstuffs, when grains, sugar, corn, soybean, wheat and other commodities are rising like hot air balloons besides oil, and not call it inflation!  Oh by the way, General Mills did have 3^rd qtr earnings rise by 18% due to global demand, not U.S. demand.  Kudos for the Emerged Markets!

It’s not without trepidation we invest in the U.S. and Europe these days (unless we see mis-pricing anomalies like in 2008).  The inflation threat is real.  Bill Gross is avoiding U.S. treasuries because he sees yields only rising due to inflation while Warren Buffet has recently stated, “I would recommend against buying long-term fixed-dollar investments,” Buffett, chairman and chief executive officer of Berkshire Hathaway Inc. (BRK/A), said today in New Delhi. “If you ask me if the U.S. dollar is going to hold its purchasing power fully at the level of 2011, 5 years, 10 years or 20 years from now, I would tell you it will not.”

Other highly rated practitioners offer similar views.  The U.S. dollar is a short in the long run.  Be prepared.

Investing in Japan in Support of Their Economy!

There is an expression among professional investors that says, “Buy on the dips”.  It comes about because investor behavior is such, that we over-estimate the impact of horrific events and under-estimate good news often.  This behavior is also linked to anchoring where the most recent events weigh most heavily in our minds.  Unfortunately, what has happened in Japan is a terrible tragedy.  Having some business acquaintances there, the first thing I did when I heard about the earthquake last Friday is email them inquiring about they and their family’s safety. Fortunately, they are okay.  However, that does not mean we cannot find reason to invest in Japan provided we keep a careful eye on events there.

Warren Buffet’s teacher Ben Graham’s focus is often about best practices and saving us from ourselves.  That certainly is what his book “The Intelligent Investor” is about, being patient, disciplined and teachable and that those qualities will allow for gains in the market even above those with extensive knowledge or experience in finance, accounting and stock market anecdotes that do not practice those virtues.  For instance, a portfolio manager I worked with, who at the height of the sell-off in February of 2009, before the correction took place stated the obvious, that stocks are being priced for bankruptcy, though many of them have earnings and no debt!  “Certainly even those with some debt have fallen far enough to be worth something!” he said.  He bought many of these stocks.  Ruby Tuesdays for instance was trading between $6 to $7 a share prior to September of 2008 for a while, than between October 2008 to March 6, 2009, it fell to $0.95 cents a share.  At this point, it was priced to go out of business but subsequently by April 9, it was trading for $6.61 a share again.  Graham said, “99 out of 100 issues at some price are cheap enough to buy and at some other price they would be so dear that they should be sold” and he wanted to embed in the reader a tendency to measure and quantify (which is exactly what any quant would argue for). So in the ensuing example of Ruby Tuesday (ticker: RT), the advice we garner from Graham, is that one should stick with stocks selling for low multiples of their net tangible assets to purchase.  But we also learn, that when the market drastically turns fearful and a sell-off occurs, it’s usually overreacting.
 

In the data that follows below for instance, we show the calculation of the current ratio for Ruby Tuesday during the melee of its share price falling to $0.95 per share.  The data shows that total assets per share stayed pretty even from May 2008 right through to May of 2009 and that the net tangible assets (Equity per Share) were about one times the share price (right scale of price graph, trading volume is left scale).  The current ratio is below Graham’s ratio of two, so it would not have passed a “Graham” screen, but when the stock traded below net assets, essentially anytime below $6 share, the stock was a buy, and when it dropped to $0.95, with a price to tangible book value of 0.20, the stock was a steal!   What an opportunity!  The market mis-priced average companies during the credit crisis as though they were overwhelmed with debt (like Ruby Tuesday) and it presented a great buying opportunity.

The ultimate result of this kind of investment strategy is one of conservation of principle but indeed has better outcomes over the long term than chasing glamorous stocks in the growth style, where forecasting future earnings is distant and vacuous as compared to measuring something as simple as net asset values.  Thus, Graham’s odyssey is really about true value discovery, about separating what the current market price says about a stock versus its real underlying intrinsic value

Now back to Japan; when you hear of reactor meltdowns, breach of containment and over-estimates of the death toll, this means that most investors and “Mr. Market” are probably going to over-estimate the future impact of these tragic events.  That’s the time to buy a Japanese Index fund or ETF.  Or, if you have the stomach for it, buy some Toyota or Honda.  These strategies will pay you dividends going forward.  You be telling the Japanese people that you are in support of them besides.  Albeit, wait a week or so for a bit (but not all) uncertainty to subside.

Chinese Slave Labor?

From time to time people say to me, aren’t you concerned about the Chinese exploiting the factory laborers like they are, paying them “slave” wages?  Now, in all honesty, most of these off-hand remarks are from Americans whose worldviews and experiences are U.S. centric simply due to their home bias.  However, it’s time to put some information together to reveal how unaware these comments are of the true situation in the Far East.

To begin, inflation is quite rampant in China, India, Singapore, Thailand, Vietnam, South Korea, Malaysia, Hong Kong, Indonesia and many other emerging markets.  Food prices, not to mention oil prices are having a huge impact on these parts of the world and as most of you know, these are crowded countries so there’s not much more land available for farming.  So, this results in inflation in these countries across most goods and services. Inflation is not only coming from the demand side, but also from the supply side for food and other commodities, not to mention oil.  The chart below from the IMF puts these numbers in perspective.  There’s no doubt prices across the globe are spiraling.

In particular unemployment is below 4% for Malaysia, Thailand, Singapore, Hong Kong and South Korea.  Industrial capacity is also above historical averages for these nations so that by most standards of economic measures, Asia is back to where it was before the global credit crisis hit in 2008.  So what will these nations do to combat inflation and what is the impact on these country’s economies due to these consumer price rises?

Well, to begin, fallout from rising prices puts pressure on businesses.  Given these low unemployment rates in the Far East, there are labor shortages beginning to occur.  Finding employees is becoming difficult and second, even if unemployment wasn’t low, rising prices means wages need to rise to subvert social unrest, an obvious issue for the Chinese for instance.  Singapore has a long history of immigrant labor and the shortage these days means that employees can switch jobs and get 20% to 30% raises just for the taking a new position.  The World Bank says Thailand raised the minimum wage 6% last year alone and is claiming labor shortages of over 100,000 for workers.  The same thing is occurring in Malaysia.  In China we’ve seen strikes and work stoppages because employees are demanding wage increases and the good news is, they’re getting them. 

The chart below breaks out inflation in the G7 developed world, developing Asia (ex-Japan) and the ASEAN-5 consisting of Indonesia, Malaysia, Philippines, Singapore and Thailand.  There’s no doubt this is making labor disgruntled and forcing wages higher.

The usual prerogative falls on the central banks and they will (and are) raising interest rates to try to choke-off the rising prices but generally, these rising prices are destructive and are straining industrial capacity and labor.  It’s making it very good for job hunters and many native born Chinese and Indians studying abroad for instance are going back home rather than staying in their host country after graduation like they have in times past.  Moreover, much of the immigrant labor from countries like Bangladesh and Indonesia that offer supply, are finding more opportunities at home.  So demand for labor is increasing while supply is falling leaving wage increases happening in order to in order to close the gap.

Unfortunately, these rising prices across global commodities combined with the developed Western world’s central banks quantitative easing as it’s called, which means printing currency effectively, is eroding the West’s standard of living and in fact debasing the currencies of these countries.  In fact the next chart illustrates this by showing the major stock indexes of the world priced not in their underlying currency, but in the currency of the commodity basket of the Reuters-CRB index prices. 

The Reuters Commodity Index is made up 19 global commodities, many of which are rising rapidly.  Thus, the chart below signifies that the currencies of the world are really falling relative to commodities and thus purchasing power is falling in Dollar, British Pounds, HKD, Yuan, Yen and Euro.

One of the considerations the governments in the developed world (U.S. Eurozone and Japan) have is how to pay the interest on their burgeoning debt.  One way, is to print money in so doing, devaluing the major currencies of the world relative to oil and gold and other commodities.  This is evident when you describe the stock market indexes in terms of underlying commodities prices versus fiat currencies.

The chart below prices the indexes over the last decade in Gold.  The run-up in Gold prices in essence is associated with the loss of confidence in fiat currencies.  It’s not just commodity demand that is causing prices of commodities to rise, but also this loss in trust of major developed world currencies due to the size of most developed world debt.

This chart above shows the last decade of the S&P500, FTSE 100, Hang Seng and Shanghai stock indexes, priced in Gold rather than U.S. dollars, British pounds, Hong Kong and Chinese currency respectively.  The HK and Chinese currencies are pegged to the U.S. for the most part, but lately the Chinese Yuan has been rising slowly relative to the dollar.  The data here is also normalized so that all indexes fit on the same scale, but this does not affect their trends which is collectively downward.  The Shanghai stock market bubble is quite evident at the height of the global credit crisis in 2008 however, but the main trend is clear, relative to gold, the earnings power of currencies is decaying.  In spite of the dollar’s short term gains against other currencies recently (not shown), the global purchasing power of currencies is falling.  Only the Australian and Canadian dollars are holding there own these days, and that can be tied to their huge natural resource exporting economies (i.e. commodities). 

The next chart shows the same data for the Reuters Commodity Index, the Nikkei 225 (Japan), CAC 40 (France) and DAX (Germany) priced in Gold rather than U.S. dollars, Yen, and Euros respectively.  Even here, relative to gold, the basket of commodities (R-CRB index) has even fallen, though not as much as the indexes.

The takeaway from these plots is like we’ve said before, fiat currencies are losing their value relative to materials and commodities.  The buying power of currencies is dropping worldwide.  This occurs along with the natural rise in inflation in the Far East due to the huge and growing demand for consumer goods and Western style food as these economies arrive into developed nation status.  Moreover, it puts pressure on wages in these countries and allows for job growth to spur considerably faster than in the developed world, which will have a long and possibly unresolved economic hangover due to the very large government debts these nations are running and not dealing with in a truly effective manner.

My investing advice is to buy hard assets and don’t keep money in currencies or government debt, but in instruments that have the potential to appreciate at least as fast as the Commodities indexes, many of which are available today to the average investor as ETF’s.

What's this World Coming To?

First of all, having traveled quite extensively in Asia over the last couple of years, I can assure you, there is no Chinese 10 year old working for a nickel.  The Chinese are quite happy about their rise in the world and the job's they have. For our economy's situation, the question isn't whose to blame, but if blame has to go around, yes it's the policiticans mostly.  But the unions are second or maybe third.   In general, the collective policitians (both sides) at state and federal level don't understand economics and neither do the unions.  However, none of it really matters because this is what's going to happen. The global situation has arisen so fast, politicians have been caught completely unaware of the competitive environment everywhere and the US just will no longer be competitive due to the welfare state we've created.  Union pensions are just part of it (but they are a considerable part of it). 

For example, in Portugal, Ireland, Italy, Greece and Spain (the PIIGS) what happened is govt payrolls grew so that 25% to 30% of the workforce were govt employees.  The US is currently at 20%.  In this last recession, the unemployment went to the private sector.  Govt payrolls did not decrease nor did govt employee retirement benefits and pay.  Essentially govt workers haven't experieced the recession like the private sector and on top of that the number of people employed by the govt grew.  This is well documented and the WSJ published the data recently.  This is the truth and has nothing to do with one person there or one person here you personally know who may have lost a govt job.  In the private sector it's much worse!  

So, just like in Paris now with labor strikes, Athens, Madrid (Spain's unemployment is over 20%!!)  and these other European welfare states, they are having to go through great pains to have cuts in govt payrolls and benefits.  There is no other way.  There is no more money.  Moreover the larger picture involves right now where the US debt is almost $15 trillion dollars.  The US GDP is also ~$15 trillion.  That means our debt to GDP is 100%.  In Greece it was %129, Spain %100.. essentially the US is just like these countries.  The saving grace is that we can print our own currency. Those countries cannot print the Euro.  Very soon, the US currency will lose it's reserve status because we keep printing and the growing clout of other nations.  When that happens, the Chinese and Asia will stop buying US treasuries.  

 

A side note, when we purchase goods made from China (and btw, if we didn't our standard of living would be way lower than it is now, because the cost of producing goods here would mean they'd cost 3 x what we pay for them at Walmart) in dollars, the Chinese govt buys those dollars from Chinese companies with Yuan and than takes those USdollars to buy US treasuries.  They own $1.8 trillion of our $15 trillion in outstanding debt currently.

 

When China and Asia stop bying our debt, we'll have to raise the interest rate we offer to incent them and others to buy that debt.  What do you think the debt service is on $15 trillion?  4% of $15 trillion is $600 billion, the same amount as our defense budget!  We pay interest equal to our defense budget each year to service that debt.  What happens when we have to pay 8%?  $1.2 trillion/year just to service the debt.  Where will money come from for govt pensions, social security, welfare etc.  You get the point?  

The state situations are also similar.  Right now govt pensions and wages are above or equal to the private sector.  When college graduates are wanting to go work for the govt rather than taking private sector jobs, your economy is gone. There is no more democracy or capitalisim.  This is where we've gotten too.  The solution is very painful and involves govt employee cuts to employement, wages and benefits and also tax increases for everybody.  There is no other way out of it.  

 

It's not a question of unfair trade with the Chinese, that's just a diversion and people saying that (union presidents and politicians) don't understand the history of economics.  Let me tell you the story.  After WWII our economy was very good and the US was the world's manufacturer.  Why?  Do you think it had to with American ingenuity?  Hardly, it had to do with fact Europe was bombed to smithereens as was Japan and Asia was still in the dark ages.  That's why GM grew revenues and market share, not because they had superior product, it was simply because nobody else could build anything.  Then came the 60's and 70's and Germany and Japan rebuilt themselves and started creating things at the low end of the innovation scale.  The low end of manufuacturing moved to Japan then due to labor costs (which is the largest cost in any manufacturing) and in the 70's Japan made things cheaply and the stories of China today we heard about Japan then.  Japan and Germany also began to do more than copy, they also began to innovate.  In the 80's, Japan started out-sourcing to the Tiger countries (HKong, Singapore, S. Korea) for cheaper manufacturing and they moved up the food chain in innovation. This is where Toyota, Sony, Honda grew.  In the mean-time the US was still a creditor nation because we still exported more than we imported, but the gap was closing as the world became competitive, as the world rebuilt themselves after WWII. 

 

Then came the 90's and the tigers shifted manufacturing to China, Indonesia, Phillipines and Vietnam where labor costs were cheaper.  S. Korea's chaebols and Samsung grew then and the tigers realized they could innovate too and stopped copying and started designing.  In the US, this is where our imports crossed our exports and we started to become a debtor nation.  A partial cause of this is because the US. consumer are the most materilistic people on earth and we kept buying stuff feeding demand and when you go into a store and see a US made TV for $1000 in 1992 and a Japanese designed, Korean built TV just as good for $500, which are you going to buy?  So to continue, the new century came (2000's) and all the Asian tigers and Japan were now having everything built in China due to cost.  But since China has so many people, the manufacturing keeps moving inland so it'll take 20 more years before the Chinese start moving manufacturing to latin american and africa.  They're building ties with these countries now by the way. 

 

So every decade from the 60's to now moved manufacturing to the lowest cost provider WORLDWIDE.  This is not a US phenomena, all companies every where do it.  Countries like Germany and Japan do it to. BUT they still are exporters not importers like the US, why do you think that is?  Because the German and Japanese people are FRUGAL that's why.  I lived there I know.  They just will not run out and buy the latest and greatest TV, iPhone, clothes, car etc.  This is how they maintain their competitiveness on a global scale.  They innovate and design and don't buy and turn the lights out when they walk out of a room.  The freakin German's don't even shower every day!  The save every penny they make.  Our cultural difference is why we run a trade deficit and these two modern countries run a trade surplus.  But, they both outsource manufacturing to China too in a big, big way.  

 

So there you have it with many runon sentences, but the problems in the US today have very little to do with Chinese labor rates and their cheap Yuan.  By the way, no country on earth has ever devalued their currency into prosperity, the Chinese know this and is why they continue to let their Yuan rise.  It's rising for sure, I keep track of exchange rates just not at the rate US politicians want it to.  Again, they think that if the Yuan rises, we'll somehow fix our export/import problem.  It won't, that's naive.  You can let your currency devalue like the dollar is now, for a little while and boost exports but you cannot do it in perpetuity for then confidence in the dollar will fall, nobody will buy it and US debt (resulting in loss of reserve currency status, high interest rates to incite borrowers of US debt and high debt service and default) and you'll create runaway inflation at home.  So by 2020-2025, Chinese GDP will equal the US.  The US is like Great Britain in 1900.  They were the world power and economic power (2 different things).  But by after WWI, the UK lost that status.  By 2030, the US will be a has-been nation and frankly, there's not stopping it, because of people's reaction like what's going in in Wisconsin right now.  The govt workers, just really do not understand the greater pickle were in.  Nor do the policitians.

 

I hope this clarifies some of the confusion.  You will not get the true story listening to union leaders and watching CNN or NBC.  Start reading Barrons, the Economist and the WSJ every day for the next 6 months to get the real picture, for union leaders and politicians just don't know exactly what it is. 

Oil Tax Breaks?

I’m an Exxon stock holder and get its annual report.  In 2009, ExxonMobil’s total taxes and duties to the U.S. government and its subdivisions exceeded $7.7 billion, an amount that includes ExxonMobil’s U.S. income tax expense related to 2009 activities of approximately $500 million. U.S. income tax expenses over the last five years reached almost $20 billion!

Furthermore, one only has to look at ExxonMobil’s previous tax bills to realize that any claim they don’t pay taxes is absurd.  XOM is one of the country’s largest taxpayers, having incurred a total U.S. tax expense of $60 billion over the past five years – a tax cost that exceeded XOM’s U.S. earnings in that same period by $19 billion. Simply stated, for every dollar of net earnings in the U.S. between 2005 and 2009, XOM paid almost $1.50 in taxes to federal, state and local governments.

Exxon is not only a large source of revenue for the government through taxes, but also invest substantial sums even in a weak economy. XOM made capital and exploration investments of $26.1 billion in 2008 and $27.1 billion in 2009, investing nearly $11 billion directly in U.S. operations during this time.   And for those who still say oil and natural gas companies “don’t pay their fair share” compared to other companies, consider XOM’s effective tax rate for 2009 was about 47 percent; a recent study found that the tax rate for U.S. oil and gas companies is about 20 points higher than the rest of the S&P Industrials.

Being in the asset management business I’m in, using FactSet I can look up company fundamentals.   From the S&P database Compustat, analysis shows that the 2009 income tax rate for U.S. oil and gas companies was about 48 percent, which was 20 points higher than the rest of the S&P Industrials.  Also according to the government’s own Energy Information Administration, from 2004 to 2008, twenty-seven American oil and gas companies, which make up under half the total oil and gas production in the U.S., paid almost $150 billion in U.S. income taxes.  Additionally, those companies paid other non-income taxes of more than $300 billion, for a total U.S. tax contribution to federal, state, and local governments of more than $450 billion.  Keep in mind, too, that Sec. 199, the manufacturing and production tax provision that is usually called a “tax break” for “big oil”, actually benefits other industries more than it does oil and gas companies.  When it comes to politics it’s time for truth to come out.  The oil industry pays far more than its fare share than most all other industries.

Moreover, Exxon can no longer “drill-baby-drill” wherever it wants to anymore, but if China National Offshore Oil Corporation (CNOOC) wants to drill in western China for instance, they will. The government will see to it with little or no environmental impact studies. In addition, the Chinese are forming tighter relationships with African governments that do not share Western multinationals’ worry about human rights violations or environmental concerns. A terrific “pro” example of this occurred during Exxon’sMay 26, 2010, annual meeting, where shareholders nominated the following proxy votes:  Special Shareholder Meetings (shareholders can call a meeting whenever)

1.      They can get a quorum rather than wait for Exxon to host one

2.      Reincorporate in a shareholder-friendly state

3.      Shareholder advisory vote on executive compensation

4.      Amendment to the equal opportunity policy

5.      A new policy on water

6.      Wetlands restoration policy

7.      Report on environmental impact of oil sands

8.      Report on natural gas production: impact of fracturing on environment

9.      Report on energy technology concerning climate change and fossil fuel impact

10.  Greenhouse gas emissions goals

11.  Planning assumptions

Would you think CNOOC has to deal with these kinds of shareholder nominated proxies? Now, not commenting on the worth of these individual shareholder-promoted proxies, consider the amount of time and attention they require from management and their related costs. It is a huge disadvantage to be a Western multinational doing business globally compared to CNOOC and Sinopec’s (SNP) responsibilities. These state-owned multinationals are not legacies of Communist central planning, either. They are very capitalistic and put profits first in their business activities, empowered and oftentimes aided by their government. One common thread apparent every day in the media is emerging among Western-style developed economies, and that is their increasing loathing of natural-resource usage. This is demonstrated, not only by their increasing legislation to raise royalty taxes and banning offshore oil usage, for instance, but also by losing the political will to allow market forces to meet global demand in the energy sector.

The real danger is that if the developed countries do not allow supply to meet demand through the use of Western multinational energy companies, China, Russia, and Brazil will. They will bridge the gap with other ideas, not necessarily free-market-based and not necessarily as environmentally conscious either, because they are willing to prioritize strategic concerns over economic returns and are open to dealing with pariah regimes. In addition, events like the BP oil spill in the Gulf of Mexico in April 2010 which drastically curtailed deep-water oil drilling for some time, as the Obama administration reacted irrationally to this situation. Unfortunately, when the United States discontinues using its own oil resources, the most likely benefactors are Russia, the Middle East, and Venezuela, which are left to fill the void that nature abhors. Those candidate countries are the reasons U.S. politicians give for funding alternative energy methods to ease our energy dependence in the first place. And by closing down oil lease sites in the Gulf of Mexico or offshore of the Carolinas, we play right into Chavez’s hands and actually put money in his pocket, which he then uses to destabilize the United States in Central America.

We should be asking the question:

Is the planet better off with natural resources in the hands of publically traded and transparent companies, investing in free-market principles, subject to shareholder scrutiny, free of the risk of too much government interference?

Or is it better off in the hands of multinationals run by foreign governments, opaque to their inner workings, less subject to profit motives (leading to higher investment because they do not need to maximize shareholder wealth and can accept lower return) and market forces, and beholden to national interests?

For the foreseeable future, we believe that current political forces will continue to serve to cripple Western resource reserves while forcing much higher capital investment to maintain and build reserves, and that this will continue unabated. This will again serve to give ascendancy to the foreign multinationals versus their Western publically traded alternatives.

Lastly, the chart below has the Russell 3000 companies breakdown by industries.  It shows the average amount of 2010 income tax these industries paid, divided by pre-tax income in yellow and divided by operating cash flow in green.  The two bars outlined in black, the 9^th pair from the left, shows energy paying one of the highest ratios.

Moreover, if we divide these 3000 companies into economic sectors as shown in the plot below, we plot 2010 income tax paid divided by market cap and also income tax divided by revenue (sales).  Again look where energy falls relative to other industries. 

These charts come from Standard & Poors database.  They are the facts, not media distortions. 

The one last remaining fact is that the Western multi-national oil companies only control about 25%, that’s right 20%-30% of the oil these days.  The Saudi-Arabians, UAE, Nigerians, Libya, Venezuela, Norway, Russia, Chinese, Brazil, the west coast offshore Africa and other countries control and distribute the other 70% to 80% of the world’s oil and largely set the price of oil.  Before the OPEC oil embargo of the late 70’s, Exxon, BP, Occidental, Chevron, Sunoco, Amoco had much to do with the control of oil, but those days are long gone.  Exxon, the largest publically traded oil company, said recently that for every 100 barrels of oil it sold last year, it only replaced it with 95 barrels and is why it’s slowly moving into natural gas these days.  They cannot find any oil that isn’t under some country controlled by some pariah regime.  Most of the world’s oil is underneath sovereign nations these days as is most of any new finds and the Western multi-nationals just aren’t getting access to it.  These countries have their own oil companies and they’re running their own show.  A chart showing the world’s largest producers is below.

Take a look at the above data.  Exxon, the largest publically traded oil producer is what, number 14^th on the list and look at its output versus National Iranian Oil Company.  All the “beef” people make about U.S. oil companies, demonstrates complete ignorance on the topic.

Another silly example of media charging oil companies with improper business practices, surrounds blaming Exxon on oil pump price gouging for instance, which can only be done if one is completely ignorant of the energy industry.  For all pump gasoline comes from refiners of which Exxon is a minor player, Valero and Sunoco and Chevron do most oil refining in this country as does BP.  A list of the top refiners in the world is shown on the next page, below where U.S. refiners are outlined in yellow.  Notice the largest U.S. refiner is number 6 on the list, meaning the top 5 largest refiners are “out-of-the-country” and not subject to U.S. environmental laws.  Also since the U.S. hasn’t built a new refinery in this country in over 30 years (EPA not allowed) gasoline is coming into this country from refiners outside of it, owned by again, by nations, not publically traded businesses.  So yes we have old out-dated refiners in this country, while China is building right now new ones right and left, just like they have 26 nuclear reactors under construction while we have none.  For the most part, the environmentalists will win their fight and drive oil companies out of the U.S., simply because they’re winning the miss-information war and turning the ignorant masses (who are getting more ignorant due to the state of the U.S. education system) into anti-energy if not anti-business, all under the guise of saving us from pollution.  This of course will make us more, not less dependent upon foreign oil and will serve to undermine the U.S. economy in the long run.